Not Immune

Health care stocks are ill. Not gravely so, but the sector has a persistent cough that it can’t seem to kick—and it may linger for a while.

These stocks typically are thought of as defensive, because demand for health care is relatively steady. People don’t stop taking medication for cholesterol or quit treating chronic illnesses just because of a dip in the economic cycle. Moreover, as the median age in the United States—driven by Baby Boomers—increases, so should demand for health care. Indeed, for the first time in U.S. history, people 65 and older will outnumber children under the age of five within the next 10 years.

Americans are projected to spend a record $2.4 trillion on health care in 2009, according to the Centers for Medicare and Medicaid Services. That’s a staggering 17 percent of U.S. gross domestic product. A dramatic increase in spending has helped fuel health care stocks, making health care one of the best-performing market sectors over the past decade.

Until now.

This sector, once deemed “recession proof,” hasn’t escaped the great recession of 2007–2009. Sector wide, everybody from big pharma to biotech to hospital equipment manufacturers has been hit. From a market peak in December 2007 to a low last March, the Dow Jones Health Care Index was down nearly 40 percent. Suddenly, the health care sector isn’t such good defense.

Hospital-patient volumes and elective surgeries have dropped, as people put off procedures. Case in point: Cosmetic surgeries were down more than 11 percent in 2008.

Now, while a slowly improving economic environment has given a boost to the broader market, the health care reform debate has left the sector and its investors in further disarray.

Take, for example, Twin Cities–based UnitedHealth Group (NYSE: UNH), one of the largest private health insurers in the country. The Obama health care plan aims to expand coverage to people who, because of pre-existing conditions or for other reasons, cannot get insurance. Some 47 million Americans live without health insurance. UnitedHealth stands to gain quite a few new members, which sounds like a boon. The rub is that many of these new members will be more expensive to insure.

Believe it or not, profit margins for private health insurers already are surprisingly low. Last quarter, UnitedHealth’s net profit margin was 4 percent, just slightly higher than the industry average of 3.4 percent. That’s a relatively thin margin when you consider the cost increases that private insurers are likely to experience given passage of a health care reform bill. This regulatory uncertainty has weighed on the stock. So far this year, UNH’s share price is up a little more than 8 percent, only about half the rise in the S&P 500.